1 Top Stock to Buy That Will Likely Benefit From Declining Interest Rates

Key Points

• Mortgage rates have fallen in recent weeks, aided over the last few days by the Fed's September cut.

• Toll Brothers' latest quarter showed resilient profitability, strong cash returns, and a healthy average selling price.

• Shares trade at just 10 times earnings, leaving room for upside if demand improves.

• 10 stocks we like better than Toll Brothers ›

As the market digests the Federal Reserve's first interest rate cut since last year and signals of more reductions to come, mortgage rates have been drifting lower. That's a meaningful shift for housing activity, which has spent much of the last two years contending with elevated borrowing costs. Lower rates won't fix affordability overnight, but the direction is finally helpful again.

That change particularly matters for Toll Brothers (NYSE: TOL), the nation's leading builder of luxury homes. Sure, the company's customers skew more affluent and less rate-sensitive than the broader buyer pool, and the business has been using financing incentives to keep sales moving. But if rates continue to decline, incentives can wind down, cycle times can normalize, and profitability can hold up or even improve.

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Resilient performance with room to run

Toll Brothers' third quarter of fiscal 2025 (ended July 31) underscored its fundamental strength. Revenue rose 6% year over year to $2.88 billion on 2,959 deliveries -- up 5% year over year. Earnings per share increased to $3.73 from $3.60 a year ago, aided by disciplined cost management and ongoing buybacks. Adjusted home sales gross margin came in at 27.5% -- down from 28.8% a year ago, but ahead of guidance.

Showing the company's resilience even in the face of high interest rates, orders were steady in dollars and mixed in units, reflecting Toll's focus on price over pace: net signed contract value was $2.41 billion -- flat year over year. But this was on 2,388 units, down 4%. The average sales price of new contracts rose 4.5% to about $1 million.

In a point of concern, backlog ended the quarter at $6.38 billion, down 10% year over year, as the company continued to convert prior orders to deliveries.

Toll returned $226 million to shareholders via buybacks and dividends in the quarter, including repurchasing roughly $201 million of stock. Its preference for repurchases shows management's confidence in the company's long-term performance.

Management's commentary reinforced the strength of the franchise.

The company also reiterated full-year guidance that implies about 11,200 deliveries and adjusted home-sales gross margin in the high 27% range -- a strong backdrop if demand trends gradually improve as rates ease.

Valuation and near-term tailwinds

There are several good reasons for investors to bet on Toll Brothers today. First, falling mortgage rates can unlock incremental demand and allow builders to pull back on rate buydowns and other incentives, which supports margins.

Second, Toll's affluent customer base and average selling prices near $1 million provide some insulation against affordability shocks.

Third, the company is sharpening its focus on its core business: On Sept. 18, Toll Brothers announced the sale of its Apartment Living platform to Kennedy Wilson. The move should unlock capital, simplify the story, and tilt the business mix further toward high-return homebuilding.

Bolstering the bull case further, Toll's valuation is reasonable for these dynamics. Shares change hands at roughly 10 times earnings, a level that isn't particularly high given Toll's margins, balance-sheet strength, and consistent cash generation. If rates continue to drift down and orders stabilize or grow modestly, that multiple may prove conservative.

Of course, there are some notable risks. If something prompts the Fed to stop lowering rates or -- even worse -- raise them, that could slow demand for new homes. And persistent affordability challenges and a broader slowdown in high-end housing could pressure orders and compress margins.

Backlog is lower than a year ago, and the industry remains competitive, with incentives still in use across many markets. But if the macro backdrop improves at the margin, Toll's positioning suggests it could be a clear beneficiary.

Taken together -- easing mortgage rates, resilient profitability amid high interest rates, improving operational efficiency, and a focused portfolio -- Toll Brothers looks like a compelling way to play a gradual housing recovery. At a reasonable valuation and with tangible catalysts, it stands out as a top stock to consider for investors looking to benefit from declining interest rates.

Daniel Sparks and his clients have no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.